Caterpillar, Eaton's Fortunes At The Whim Of Chinese Demand

We and others in our industry write often about the impact on metal prices and supply as a result of rising demand in the emerging markets and, in particular, China.

China has, without a doubt, been the largest single driver of metal prices over the last ten years as the country’s phenomenal growth, much of it investment-led, has sucked in mind-boggling quantities of iron ore, coal, base metals and other commodities.

At the same time, the wealth created by that growth has gradually permeated through Chinese society, resulting in a rising middle class keen and able to buy foreign-made products.

The investment in infrastructure has been the single-largest factor within China’s growth story when it comes to metals demand. China’s construction sector has spanned public works like airports, highways, seaports, railways, public buildings, bridges and so on, in addition to a massive residential and commercial construction sector which has added hundreds of millions of square feet of apartments and office blocks – all of which have consumed steel and base metals.

This activity has in turn spurred the development of the world’s largest steelmaking and smelting industries for copper, aluminum, lead, zinc and other metals. The supply chain has responded dynamically with the growth of manufacturing to supply the equipment to enable these undertakings to happen.

So much is well known and nothing new, but as China forces a dramatic realignment in its economy from being export-led to domestic consumption-led — a change that historically has taken decades in other economies but, as in many things Chinese, is happening in a few short years in China — the rest of the world is finding the playing field changing rapidly before their very eyes.

An article in the FT explores the impact on several US corporations who have invested heavily in Chinese manufacturing capacity, but who are finding domestic Chinese demand slowing much faster than they had expected. This is not a case of nearshoring, of rising Chinese costs undermining the economics of manufacturing in that country; it is a case of the demand for manufacturers’ products being stronger outside of China than within it.

The report focuses most squarely on Caterpillar (NYSE:CAT), which has built 16 manufacturing facilities in the country, with nine more said to be under construction. It employs 11,000 workers in China, and has plans to double its workforce there by 2015.

Caterpillar is at pains to say its long-term commitment and confidence in China remains as resolute as ever, but for the time being the firm is seeing demand falling, to the extent it is having to export earth-moving and construction equipment made in China to overseas markets as demand has collapsed.

Fortunately demand is rising strongly in the US and Latin America, with decent growth in the Middle East and Russia. And Caterpillar is not alone: Eaton (NYSE:ETN), another household name as a manufacturer of industrial equipment, is raising its demand expectations in the US from 6 percent to 9 percent, while downgrading those elsewhere from 4 percent to 2 percent.

DuPont (NYSE:DD), the chemicals giant, said sales rose by 30 percent in the Middle East and 23 percent in Latin America from last year, while revenues fell 2 percent in Asia. United Technologies, also exposed to the construction sector in China, said Chinese orders fell by 15 percent in the first quarter, with demand at its Otis elevator unit dropping by 21 percent, but orders rose by one-fifth in Brazil, India and Russia.

The shift may prove temporary, but Beijing is working hard to realign the economy away from relying on exports and fixed investment for growth and more towards internal consumption.